Asset-based lending

Definition

Asset-based lending is a form of business financing where a company secures a loan or line of credit using its assets as collateral. Unlike traditional loans that primarily rely on creditworthiness, asset-based lending is based on the value of the company’s assets, such as accounts receivable, inventory, equipment, and real estate.

What is asset-based lending?

Here are the key components and points about asset-based lending:

1. Collateral-centred: Asset-based lending centres on the value of a company’s assets. Lenders evaluate their quality, liquidity, and marketability to determine the funding amount.
2. Types of collateral:
   • Accounts receivable: Unpaid invoices from customers are considered a common form of collateral. Lenders may advance a percentage of the total receivables’ value.
   • Inventory: Both finished goods and raw materials can be used as collateral. The lending amount is typically based on the inventory’s current market value.
   • Equipment and machinery: Tangible assets like machinery and equipment can be leveraged for financing.
   • Real estate: Owned properties can be used as collateral, although this is more common in larger, long-term arrangements.
3. Revolving line of credit: A common structure in asset-based lending is a revolving line of credit. This allows the borrower to take out funds up to a specified limit, repay, and use again, much like a business credit card.
4. Interest rates and terms: Interest rates for asset-based lending tend to be higher than traditional loans, reflecting the risk involved. 
5. Flexibility and availability: Asset-based lending can be more flexible than other forms of financing. It is often used by companies facing rapid growth, seasonal fluctuations, or financial challenges.
6. Risk and benefits: Asset-based lending offers financing but carries the risk of asset loss if the borrower defaults. So, companies should weigh benefits against risks before opting for asset-based lending.

Overall, asset-based lending can be a valuable financing option for companies with substantial tangible assets, providing them with the working capital needed to grow and thrive in their respective industries.

Example of asset-based lending

XYZ Manufacturing is a mid-sized company specialising in producing custom machinery. It has a diverse range of assets, including accounts receivable and inventory.

The company needs additional capital to fund a new product line and improve working capital.

1. Asset Evaluation:
   • The company’s assets, particularly accounts receivable and inventory, are evaluated. Let’s say XYZ has $500,000 in accounts receivable and $700,000 in inventory.
2. Asset-based lending agreement:
   • XYZ enters into an asset-based lending agreement with a financial institution. The lender agrees to provide a revolving line of credit based on a percentage of the assessed value of the company’s accounts receivable and inventory.
3. Loan amount calculation:
   • The lender may offer, for example, 80% of the value of accounts receivable and 50% of the value of inventory. The maximum loan amount would be calculated as follows:
     Loan amount = $400,000 = $350,000 = $750,000
4. Repayment:
   • The loan is a revolving line of credit, and as XYZ receives payments from customers or sells inventory, it can repay the borrowed amount. Interest is charged only on the outstanding balance.